Read the Harvard readings: 1. The Cost of Capital: Principles and Practice and 2. Estimating Walmarts Cost of Capital.

Question 1: What is the cost of capital? Why do managers care about cost of capital?

Question 2A: Compute Cost of Debt in 2019 using method 1 and method 2

Method 1: Historical Cost of Debt Financing Approach

• Step 1: What is Walmarts total amount of short-term and long-term interest-bearing debt in 2019 from the liability section on the balance sheet?
• Step 2: What is Walmarts interest expense in 2019 on the income statement?

• Step 3: Compute 2019 average interest rate = = ?
• Step 4: Compute 2019 after-tax cost of debt = Avg. interest rate x (1 effective tax rate) = ?

Method 2: Walmarts Long-Term Bond Approach

Instead of using the average interest rate in Method 1, use Walmarts 30-year bond yield rate that manager Lee provided on page 2. You will use the after-tax cost of debt results from method 2 to estimate the WACC in Question 4.

• After-tax cost of debt in 2019 = Walmart 30-year bond yield rate x (1 effective tax rate) = ?

Question 2B: Debriefing

1. What is the drawback of using (Method 1 in Question 2) Walmarts average interest rate to estimate its cost of debt?
2. What makes using (Method 2 in Question 2) Walmarts long-term bond issued in 2000 a better way to estimate its cost of debt?
3. What is the benefit of using deb-financing as opposed to equity-financing?

Question 3: Use Capital Asset Pricing Model to estimate Walmarts cost of equity:

• Step 1 Obtain Risk-Free Rate ₂₀₁₉: Use Feb 19, 2019s 10-year US Treasury Bond Yield that manager Lee stated on case study page 2 as your Risk-Free Rate ₂₀₁₉
• Step 2 Compute Market Risk Premium (see Exhibit 5):

The formula for Market Risk Premium = Market Rate _1928-2018 Risk-Free Rate _1928-2018

• • Step 2a: Use S&P 500 Index Geometric Average Annual Returns: 1928 2018 as your Market Rate_1928-2018
  • Step 2b: Use the Return on 10-year Treasury Bond Geometric Average Annual Returns: 1928 to 2018 as your Risk-Free Rate _1928-2018
• Step 3 Adjusted : Enter the Bloomberg adjusted beta (see case study page 3) in step 3
• Step 4 Estimate 2019 Cost of Equity using CAPM
  • Cost of Equity = Risk-Free Rate ₂₀₁₉ + (Adjusted Beta x Market Risk Premium)

Question 4: What is the overall Weighted Average Cost of Capital for Walmart in 2019?

• Step 1: D = Book value of all interest-bearing debts from balance sheet in 2019 = ?
• Step 2: E = Book value of equity 2019 = BV common stock & paid-in capital + BV retained earnings = ?
• Step 3: Weight of debt = D/(D+E) = D/V?
• Step 4: Weight of equity = E/(D+E) = E/V = 1 (D/V) = ?
• Step 5: WACC = (D/V) x (after-tax cost of debt from method 2) + (E/V) x (cost of equity) = ?

Question 5: What key takeaways do you gain from this case study?